Making monkeys out of markets


IT’S now official. Even monkeys can beat the stock market index. Cass Business School researchers in London simulated 10 million portfolios of US stocks selected at random. They found that a US$100 invested at the beginning of 1968 would have yielded US$5,000 by the end of 2011, but half the monkey (computer-simulated) portfolios managed US$8,700, one quarter made more than US$9,100 and 10% made more than US$9,500.

Monkeys

So, does the market beat all the professionals if monkeys beat the market?

There is a real lesson here for investors. I had a great debate with a good friend last month regarding the benefits of investing in a world where fast trading algorithms (using super fast computers to detect market opportunities to buy, sell or short stocks make it hard even for traditional asset managers to compete. So what chance is there for retail investors? My friend decided to get out of trading stocks.

Investing has been such complicated business because there are just too many variables to handle. Gone are the days when you think you can understand how markets perform. The rules of the game changed when policymakers began intervening through unconventional monetary policy and politics become part of the equation.

You would have thought logically that growth economies should produce growth stocks. The BRICS economies (Brazil, Russia, India, China and South Africa) met in Durban at the end of March. These five countries accounted for over half of total global growth since 2001, but their stock markets have not done that well. Since its peak in 2007, the BRICS index is down 37%.

Chinese retail investors have declined in number, based on the number of accounts closed. The A share index is down 31% since its peak in 2009, and the Brazil, Russia, India and South Africa stock market indices are all in negative territory since the beginning of this year. On the other hand, both the US and Japan are sluggish in growth and their stock markets performed 11.1% and 20% respectively since the beginning of this year.

Despite being overall in crisis and negative growth, even the European stock market performed in positive territory, mainly due to better performance in Germany and France. There are globally diversified companies in these economies that can outperform despite the slowdown in the European economy.

The real problem is that negative real interest rates around the world are truly destroying the ability of investors to judge what is the right asset to invest in. Markets are clearly bubbly when emerging market investors start investing in taxi licenses.

Accordingly to a Bloomberg report, Turkish taxi licenses today trade for US$580,000 each. My Hong Kong taxi driver was complaining to me that a Hong Kong taxi license was trading over HK$7mil (just under US$900,000) and yielding next to nothing.

It made no sense to him as a taxi driver himself to be an owner. This reminded me that in 1996, golf club membership was being touted as the best investment ever, with the 1997 Asian financial crisis wiping out all gains thereafter.

So what should an honest, no-inside information retail investor do? I guess the old-fashioned advice to invest in diversified and value stocks and maintaining ample liquidity is still sound. Global bonds have done well since the financial crisis due to the massive quantitative easing.

Even those who have speculated on Greek bonds when they were yielding more than 20% have done well. But it is difficult to argue that ten year US Treasuries and German Bunds at under 2% per annum represent no risk. Certainly, Japanese 10 year bonds at 0.55% per annum, when the official inflation target is 2% per annum, must carry considerable interest rate risks.

Over the long-term, there is no question that investing in one’s own home has been good investment. This is officially supported leveraged investment, since most mortgages still require not more than 30% down payment for the first home. The fact that there is a growing middle-class in most emerging Asia means that demand for housing is still on the increase, but given such low interest rates, it is hard to imagine how much further can house prices rise relative to the affordability index.

My own inclination is to go for high yield, solid growth companies that are globally diversified. You basically invested in the region that you are most familiar with, and in companies that demonstrate good governance and know what they are doing. The average price/earnings ratio of Hong Kong, Singapore, Malaysia and Thailand markets are still below those of the US (17.7). China A share has a PE ratio of only 8.1 and a yield of 3.7%.

Of course, the art of investing depends completely on the investor’s risk appetite, age and liquidity requirements. If you are fully invested in illiquid assets or in illiquid markets, you cannot get out even though the returns look good. Property markets are notoriously easy to get into and difficult to cash out, especially in the smaller markets. Bond investments may look good on paper, but when you want to exit, the selling price may be lower than what you think you can get, especially for retail investors.

Knowing that even monkeys can beat the market gives one food for thought. You can do better, but you must invest the time and energy to think through what you are investing in, what risk you are taking and what you want to achieve. My friend in Australia had no formal training in investments, decided that she could outperform the market, relied on her instinct and own research into companies and is now doing pretty well on her own.

Even monkeys know how to survive, so don’t look down on monkeys.

THINK ASIAN By TAN SRI ANDREW SHENG

Tan Sri Andrew Sheng is president of the Fung Global Institute. He was recently named by Time magazine as one of 100 most influential people in the world.

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The state as market


THE more I study the Indian and Chinese growth models, the more I realise that the current debate over the state versus the market is a false dichotomy.

Both the state and the market are social institutions that are not independent of each other. Indeed, they are inseparable, interactive and interdependent.

Human development or evolution is a complex interaction or feedback between the two. In Small is beautiful author EF Schumacher‘s view, “Maybe what we really need is not either-or but the-one-and-the-other-at-the-same-time”.

India and China could not have become global powerhouses of growth, without the leading role of the state in planning for development. But those states that have worked with markets have succeeded better than those that worked against markets.

London Business School Prof John Kay defines the market as a relatively transparent, self-organised, incentive-matching mechanism for the exchange of goods and services, usually in monetary terms.

In plain language, the market helps to match willing buyer, willing seller under certain rules of the game to determine market price. The market clears when it functions properly, but market failure happens when the market is imbalanced.

Kay reminds us that capitalism is less about ownership than “its competitive advantages its systems of organisation, its reputation with suppliers and customers, its capacity for innovation”.

Because of globalisation and technological change, we are living in a situation of change within change, as if the national state is not in total control of our destinies. Because of the global economy, state policies such as monetary, exchange rate and trade, cannot be independent of what is happening globally.

No man, no company, no state is an island. Globalisation has changed the rules of the game irreversibly.

Why is the state so much bigger and more powerful than before?

In the 19th century, most governments were not larger than 15% of GDP. By 1960, the size of governments in OECD countries had doubled to 30% of GDP. Today, the average has increased further to 40% of GDP.

The state has grown because there has been demand for more and more state services, but there is also concern that bureaucracies tend to grow to perpetuate itself.

I find it useful to think about the state as a market-like institution for exchange of power (in non-monetary terms). Power comes from social delegation the people give the power to the state to protect them and to fairly enforce social rules and laws. Hence, the “state as market” has the same dilemmas as the market information asymmetry and the principal-agent problem.

In large countries like India and China, there are many levels of government central, provincial, city, town, village and rural governments, each with their own departments and even enterprises. Most citizens find it difficult and confusing to deal with complex bureaucratic power. The Peruvian economist Hernando de Soto was one of the first to point out that rural poverty exists, because the poor’s property rights are not protected adequately and their transaction costs are extremely high because of complex government.

In other words, markets are efficient and stable when the state is efficient and stable. It is not surprising from recent experience that financial crises are results of governance failures. As the European debt crisis amply demonstrates, financial markets cannot clear when the fiscal condition of the state is on shaky grounds, and there is no mechanism to make fast, simple, clear decisions.

Finding the right balance between state and market is the real challenge in all economies today. As 20th century British philosopher Bertrand Russell reminded us, “people do not always remember that politics, economics and social organisation generally belong in the realm of means, not ends”.

Today’s demands on the state to provide stability, growth and social equity are complex, because recent dominance of free market ideology has ended up with serious problems of wealth and income disparities and environmental degradation.

Realising that large states with geopolitically significant human and ecological footprints cannot consume like the United States or Europe on a per capita basis, China and India are embarking on ambitious 12th five-year plans to change their growth models to become more environmentally sustainable economies with greater social inclusiveness.

But large economies with many layers of government struggle between centralisation and decentralisation of people, resources and power.

For systems to be stable and sustainable, they have to be adaptable to complex forces of change from internal and external shocks.

To maintain integrity, there are complex trade-offs between winners and losers in each society. Such rules and bargains are difficult when the causes and effects of losses are unclear (such as crisis) and when vested interests resist change for fear of losing what they have. Vested interests are often unwilling to change because they value present gains far more than uncertain futures. Politics is the compromise of contending interests.

The belief that markets are always right assumes that markets always balance. The market cannot balance when the state cannot balance the contending interests. The main reason for the advanced country debt crisis is because their consumption has happened today by postponing the costs to future generations.

This raises a fundamental problem. Whichever way you term it, central bank quantitative easing is ultimately state intervention.

The rise in Spanish bond yields, despite ECB long-term refinancing operations, suggest that the markets are saying there are limits to the growing euro public debt.

At the same time, global financial markets are watching carefully whether inflation in China and India will rekindle global inflation.

In other words, the anchor of global financial stability rests on state debt stability. The state cannot escape being priced by the market.

THINK ASIAN By ANDREW SHENGAndrew Sheng is president of the Fung Global Institute.

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